Bonds

Inflation Worries Send Prices of Long Bonds Lower

Reuters
WATCH LIVE

Long-dated government bond prices slid Thursday after a report showing growing exports exacerbated worries that inflation could get out of hand if the Federal Reserve keeps cutting interest rates, as signaled by the central bank's chief.

The 30-year bond fell for a third straight day, pushing its yield to the highest level of the year.

The move initially was driven by data showing that record exports late last year helped shrink the U.S. trade deficit in 2007 for the first time in six years.

Fed Chairman Ben Bernanke hinted more rate cuts were likely, an unwelcome signal for holders of longer-maturity bonds who worry the Fed may let inflation get out of control.

Bernanke was testifying to the Senate Banking Committee.

"All you are going to do is get inflation and that is what is causing the steepening of the yield curve," said Jim Cusser, senior vice president and portfolio manager with Waddell & Reed Investment Management in Overland Park, Kan.

"This is caused by the Fed cutting and expectations of more cuts, when sectors of our economy are not doing all that badly," Cusser said.

Long-dated bond prices were pummeled early in the session by a narrower-than-expected U.S. December trade gap, which hinted the chances of recession were receding slightly.

But broad weakness in U.S. stocks helped underpin the bond market, and Bernanke's comments were seen as supportive to 2-year notes, which are the most sensitive to expectations for Federal Reserve rate cuts.

Bernanke said the Fed will act as needed to help the struggling U.S. economy, saying it is possible that housing, labor and credit conditions could worsen more than anticipated.

The fed funds target rate is at 3.0 percent, down from 5.25 percent in September.

The 30-year bond's yield briefly surged above 4.60 percent to the highest levels since December.

The benchmark 10-year Treasury note's price fell 15/32 for a yield of 3.79 percent, compared with 3.74 percent late Wednesday.

By contrast, short maturities' yields traded near the lowest levels since 2004. Stress in the municipal bond market and concerns about bond insurers that guarantee part of that sector have rekindled the safe-harbor bid that has boosted government securities for the past half year.

The two-year note was up 1/32 in price for a yield of 1.91 percent, compared with 1.92 percent late Wednesday.

The gap between yields on 30-year bonds and 2-year notes will steepen further, to 300 basis points as the Fed continues to cut rates if inflation concerns linger, Cusser said.

The benchmark 10-year Treasury note yield's gap above the 2-year note widened to about 185 basis points, the steepest since July 2004.

"The long end hasn't responded at all to the credit crisis," said John Spinello, Treasury bond strategist with Jefferies & Co. in New York. "It is really the short end getting the safe-haven bid. In the last two weeks the trend in the back end has been toward higher rates."

Inflation concerns, expectations of increased Treasury issuance, selling by mortgage accounts and an intensification of yield-curve-steepening trades also took a toll on the long bond, traders said.

late on Wednesday.